DEALBOOK; Humanitarian Effort in Congo Puts Wall St. Regulator in Unintended Role

By STEVEN M. DAVIDOFF

Published: August 29, 2012

Securities and Exchange Commission.

Not surprisingly, having your capital markets regulator engage in foreign policy may not be the best solution to ending a war.">

War in the Democratic Republic of Congo has been deadly, with millions murdered. So the United States government has taken its most significant step to try to halt the horror: send in the Securities and Exchange Commission.

Not surprisingly, having your capital markets regulator engage in foreign policy may not be the best solution to ending a war.

The problem arises from the noble attempt to stop the sale of conflict minerals, the focus of those who are pushing for a nonmilitary way to curb the fighting in Congo. Conflict minerals include coltan, cassiterite, gold and wolframite, and while you may not be familiar with some of these, they are widely used in electronics. Your cellphone may very well contain them.

Humanitarian groups say these minerals are being mined by combatants in Congo and neighboring countries and sold to pay for military activities that lead to abuses of human rights. Activists from the Enough Project, a nonprofit group that seeks to end crimes against humanity, have been working to stop the trade in these minerals, seeking to deprive the Congo war of financing.

So where does the S.E.C. come in?

The Dodd-Frank Act was intended to overhaul financial regulation, but it was also turned into an aircraft carrier as legislators dumped in almost every financial reform proposal ever dreamed of. The 1,500-some-odd provisions of the Dodd-Frank Act not only enhance the regulation of banks, they also require shareholder advisory votes on executive compensation and require the S.E.C. to explore ending the arbitration of investor claims.

Way at the back, in Section 1502, legislators addressed conflict minerals. This provision directs the agency to promulgate rules requiring public companies to disclose whether they handle conflict minerals that originated in Congo and about a dozen or so neighboring countries and to detail the procedures used to monitor this trade.

Last week, the S.E.C. adopted rules covering conflict minerals, and they are doozies.

They require that every one of the 6,000 or so public companies determine whether they manufacture a product for which conflict minerals are "necessary to the functionality or production of a product." If so, then the company must conduct an inquiry that is "reasonably designed" to determine whether the conflict minerals came from Congo or adjacent war-torn areas.

If the company has reason to believe that conflict minerals came from Congo or related areas, it must report to the S.E.C. on its efforts to monitor the source and chain of custody of those minerals and have those efforts overseen by an independent auditor.

For human rights advocates, these steps, which are supported by the State Department, appear to be a simple but important effort to ending the horrific combat in Congo.

But if that was the intent, these rules may not be the best route.

For public companies, these provisions are expensive. A company like Ford Motor or Caterpillar, let alone Apple, can use parts and minerals from tens of thousands of suppliers and produce hundreds of products.

The S.E.C. estimates the initial compliance cost to be $3 billion to $4 billion, with continuing costs of $207 million to $609 million a year. Industry-sponsored estimates go higher, pinning the cost at $8 billion to $16 billion.

While you might think that it would be easy to define conflict minerals and regulate their supply, the S.E.C. found that it was very hard. The agency had to deal with how to treat recycled conflict minerals, what exactly it means for conflict minerals to be necessary for a product and how hard companies must work to review their supply chains, among other issues. All in a world where gold mined anywhere is hard to trace.

As you might expect with a complex issue, a complex rule has resulted. The S.E.C.'s release explaining its conflict minerals rule is 356 pages long. Companies are going to have to spend millions just to understand the rules.

But even beyond their expense and complexity, the real question is whether these rules are appropriate. Transparency and disclosure appeal to everyone. Who can argue with companies being more transparent?

But disclosure can have perverse effects. In the case of executive compensation, more disclosure likely allowed executives to know what others were paid and demand higher pay for themselves.

In this case, disclosure may impose substantial costs on companies without corresponding benefit.

Along these lines, an S.E.C. commissioner, Troy A. Paredes, wrote that he voted against the rules because they failed to assess "whether and, if so, the extent to which the final rule will in fact advance its humanitarian goal as opposed to unintentionally making matters worse."

The problems could be manifold. These new rules could lead to manufacturers simply refusing to buy any of these minerals from Congo and surrounding area. This would be a de facto boycott that could harm the populace more than it would help. The rules could also have little benefit as smugglers simply circumvent them.